21 February 2025: Reeves is proposing another “tax raid”

The Chancellor seems about to make another extremely unpopular decision in her spending review, which she will deliver to Parliament next month.

Rachel Reeves has been meeting with the financial industry to gather ideas on boosting the UK economy, and one solution could be reforming the ISA market.

This would be unpopular with savers but would increase tax revenue, making it more difficult for them to commit to their long-term futures.

Reeves is also totally committed to defence opening being capped at 2.5% of GDP. President Trump has called for all NATO members to commit to spending 3% of GDP, although there is speculation that he may increase that to 4% or even 5%.

Yesterday, the Chancellor declared her commitment to raising annual spending on defence from 2.3% of GDP to 2.5% but warned that “difficult choices” would be needed to fulfil it.

The comments will warn Cabinet Ministers in other departments that they will be expected to find cost savings.

It has become clear that the Chancellor will not want to increase overall spending in her review, so savings will need to be made from other departments that are not currently ringfenced.

As the headline inflation rate returned to 3.0% in January, it is likely to slow down the Bank of England’s trajectory in cutting the base rate.

The inflation rate was 2.5% the month before, while the Bank had expected inflation to rise to 2.8% in January.

Earlier this month, the base rate was cut from 4.75% to 4.5%, while two members of the Bank’s Monetary Policy Committee favoured a more drastic reduction of 0.5% to 4.25%, raising the prospect of three further base rate cuts this year.

That roadmap now looks more unlikely.

This will add to the burden of homeowners, although the housing market had a buoyant 2024, according to the latest figures. The expectation that interest rates would continue to fall has encouraged those who were expecting to either remortgage or move on since their costs would be significantly lower going forward.

Those who intend to stay put will now have less money to spend, which will hit both consumer spending and confidence.

Sterling moved higher, well above 1.2600 against the US Dollar in yesterday’s trading session.

The GBP/USD pair gained as the market sentiment is slightly favourable for risk-perceived currencies, with investors gaining confidence over the potential Russia-Ukraine truce, which has also improved the market mood.

It reached a high of 1.2671 and closed to that level. This was its highest closing level since mid-December, although with the Fed likely to match any pause in rate cuts over the next two quarters, any advance for Sterling may be difficult to achieve.

Economists are beginning to come around to the view that President Trump may have blundered in calling for the Federal Reserve to cut the Fed Funds rate while at the same time continuing to impose tariffs on U.S. imports, which will likely see inflation, if not rise, then certainly take considerably longer to fall to the FOMC’s target level.

There is even some speculation that Trump may consider scrapping the 2% target, which is, in any case, an arbitrary level having no direct meaning to either the economy or financial markets.

One of President Donald Trump’s major promises during the 2024 presidential campaign was to launch mass deportations of immigrants living in the U.S. without legal authorisation.

The U.S. Immigration and Customs Enforcement agency has said that, since January 2025, it is detaining and planning to deport 600 to 1,100 immigrants a day. That marks an increase from the average 282 immigration arrests that happened each day in September 2024 under the Biden administration.

This current trend would place the Trump administration on track to apprehend 25,000 immigrants in his first month in office. On an annual basis, this is about 300,000, far from the “millions and millions” of immigrants Trump promised to deport, even though it is a sizeable number.

A lack of funding for immigration officers, immigration detention centres and other resources has reportedly impeded the administration’s deportation work due in no small part to the work of Elon Musk’s Department of Government Efficiency, which is acting like a chainsaw cutting through Federal spending as the deregulation effort moves up a gear.

The publication of the minutes of the latest FOMC meeting may make a painful reading for the President since the rate-setting committee appears to have committed to its “wait and see” policy towards loosening monetary policy, considering the “fog” which surrounds economic policy decision-making.

On Wednesday evening, Fed Vice Chair Philip Jefferson said that the U.S. central bank has time to weigh its next monetary policy move, citing a robust economy and still above-target inflation.

“The performance of the U.S. economy has been quite strong overall,” Jefferson said in the text of a speech to be delivered at a gathering at Vassar College. He said the job market is in “a solid position” while noting inflation has come down quite a bit while remaining elevated relative to the central bank’s 2% target.

“Bumpy” progress back to the target was likely following a percentage point’s worth of rate cuts last year. “I believe that, with a strong economy and a solid labour market, we can take our time to assess the incoming data to make any further adjustments to our policy rate,” Jefferson said.

The U.S. dollar fell against major currencies on Thursday as investors took a step back and assessed President Donald Trump's latest tariff plans, while the yen rose to an 11-week high versus the greenback as bets increased for further rate hikes by the Bank of Japan.

U.S. data showing initial jobless claims, which were in line with expectations, and a report indicating factory output growth slowed in the mid-Atlantic region in February had minimal impact on the currency market. The reports have not changed expectations that the Federal Reserve will remain on hold for several months.

The dollar index lost further ground, falling to 106.34 and closing at 106.36.

Isabel Schnabel has reignited the flame under her hawkish tendencies following a (brief) period in which she went along with loosening monetary policy without fully committing to lower interest rates.

Now following several rate cuts voted for by members of the ECB’s Governing Council, she has returned to her more familiar guise of “hawk in chief” by suggesting that the Bank should be having conversations about when to pause, even though rates are still significantly above the perceived “neutral rate”.

Her remarks indicate that the ECB may pause and consider the effect of more rate cuts, as they risk inflation rising again, even though the current state of flux in the global economy means that monetary policy needs to be less restrictive.

It is too early to say that the Bank will consider a pause. This is more an indicator of the power that Schnabel wields as one of the two reliable sources of comment on monetary policy intentions and decisions.

In Germany, Durable goods and capital goods prices were responsible for the slight rise in demand, but the figures indicate the economy continues to struggle with weak overall productivity and increased international competition.

Producer prices inched up 0.5% on an annual basis in January, easing from December's 0.8%, which was also an eighteen-month-high, according to official figures from the Federal Statistical Office.

Although January's number was lower than analyst expectations of 1.3%, it was still the third consecutive month of producer inflation. This was primarily because non-durable consumer goods prices increased by 3% in January 2025, compared to the same month last year, whereas durable consumer goods prices inched up 1.1% on an annual basis.

On the other hand, energy prices dropped 1% in January 2025 compared to the same month in 2024. This was mainly because of natural gas, electricity and district heating prices falling, although oil and derivative prices rose.

According to the Federal Statistical Office, Germany's economy shrank by 0.2% in 2024, highlighting the second year in a row of negative growth. This was mainly because of higher energy costs, weak export demand, soaring international competition and ongoing uncertainty in the global political and economic outlook.

In France, inflation, industrial decline, and horrendous debts feed a galloping pessimism, and the 2025 budget does not provide even a scrap of optimism to the country.

Energy and manufacturing product prices also contributed to higher inflation in January as France continued to deal with increased political upheaval.

January's annual inflation rate was up to 1.7%, above market estimates of 1.4% and higher than December's figure of 1.3%, according to official figures from INSEE.

The increase was mainly caused by a rise in services prices, up 2.5% on the same time last year and 2.2% in December. Energy prices were also higher, jumping 2.7% last month, up from 1.2% in December.

Oddly, France comments that energy prices were lower while Germany spoke of their fall last month.

The euro climbed to a high of 1.0503 yesterday but is still being rebuffed on any attempt to break a level of resistance, which is encouraging traders and investors to sell on any approach to the 1.05 level.

The official inflation date is scheduled for release on Monday, and this is likely to have a far greater effect on the ECB than hawkish comments from those with hawkish tendencies.

Have a great day!